Rules targeting risky loans spark worry
The new regulations stem from an international effort to strengthen the financial industry worldwide. Basel III, named after the Swiss city in which the idea was conceived, was passed down by the Federal Reserve Bank on July 2, and includes several provisions that will impact community banks when the phase-in of the rule begins on Jan. 1, 2015.
The rules mean all banks — large international as well as small community lenders — will be required to boost capital levels from 4 percent to 6 percent and keep more cash on hand to offset the risk associated with certain high-risk commercial real estate loans.
The extensive set of rules has raised concern among community banks, which feel the regulatory burden will be too great.
Community bankers long have been perplexed about why a set of international banking rules meant to reign in banks that span multiple countries also is applicable to community banks with less than $50 billion in assets.
“These rules add more regulation and confusion,” said Mark Bower, chief financial officer of Loveland-based Home State Bank. “They should only be applied to international banks.”
The Fed did, however, make some concessions to community banks, Bower said, including allowing them to continue using something called trust-preferred securities. These securities count on a bank's balance sheet as a form of capital.
The new rules mean many banks likely will have to raise new capital, according to James Kendrick, vice president for accounting and capital policy at the Independent Bankers Association. This could mean going to current and potential shareholders to raise common equity, which isn't always easy, Kendrick said, especially now as the nation struggles to recover from the Great Recession.
“We're in a difficult environment for raising equity,” Kendrick said.
Tier 1 capital, often considered the best indicator of a bank's health, combines common equity and retained earnings, as well as other assets such as trust-preferred securities. The minimum ratio allowed for Tier 1 capital is currently 4 percent, but Basel III will raise it to 6 percent.
On top of the new capital requirements, Basel III also mandates a never-before-used “capital conservation buffer,” which adds another 2.5 percent to nearly every type of capital ratio at every bank nationwide, according to Kendrick.
This means that the new 6 percent Tier 1 capital ratio effectively will be raised to 8.5 percent, according to Kendrick.
In spite of the large increase, most community banks' capital ratios are high enough to accommodate the change, Kendrick said.
Bower's Home State Bank is one such institution, with a Tier 1 capital ratio of 8.63 percent as of March 31, according to the bank's quarterly regulatory filing.
But Bower said he still is concerned about the tougher commercial lending standards.
In an effort to rein in lending that regulators deem risky, certain types of commercial real estate loans will require that banks maintain a 50 percent higher capital ratio.
This subset of loans finances the acquisition, development or construction of large speculative commercial and residential projects. Exceptions apply for one- to four-family residential properties, certain community development projects and agricultural land, among others.
Requirements such as this could affect developers if banks shy away from these kinds of loans, according to Don Childears, Colorado Bankers Association president and chief executive.
The new rules may also mean that banks will have to charge more for these riskier loans to cover their capital costs, according to Mark Driscoll, president of First National Bank.
The timing for these changes is “terrible,” Driscoll said, because community banks have made it through the recession and are trying to grow again.
In spite of the changes, community bankers are thankful that the Fed heeded some of their requests.
“Community banks wanted outright exemption from Basel III,” Kendrick said. “Community banks did achieve some big victories that shouldn't be understated. The harshest pieces of Basel III were scaled back.”
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